Do Analysts Contribute to Auditor Discipline? Evidence from a Natural Experiment

• In Event: Audit Risk, Auditor Discipline, and Audit Pricing

Abstract

I study the causal effects of analyst monitoring on audit effort. Security analysts, who are considered to be sophisticated financial statement users, are perceived to scrutinize auditor verified financial statements. I predict that the perceived analyst scrutiny will cause auditors to change their effort level ex ante. I use broker mergers to identify changes in analyst coverage that are exogenous to audit effort. Using a rich set of matched control samples and the difference-in-differences approach, I find firms that lose an analyst experience reduction in audit fees, compared to similar firms that do not lose an analyst. I find the effect of analysts on audit fees to be stronger for smaller firms. The results are robust when I combine matching with regression adjustments. I find that the exogenous analyst coverage termination’s effect on audit fees remains after I control for the change of a wide range of firm characteristics, including the classical audit fee determinants in the prior literature and variables likely to be associated with the merger event and change in audit fees such as institutional ownership, return on assets, average monthly stock return, stock return volatility and stock turnover. The finding shows that analysts’ effect on audit fees is not caused by its effect on these firm characteristics. Overall, the results suggest that analysts have a disciplining role on auditors.

Author

• Ti Gu, The University of British Columbia